Report
I. 'Introduction' ' ' The airline industry has changed significantly over the years evolving with advancements in technology, socio-economic factors, and political interventions. Various incidents especially the events following 9/11 had a huge impact on the airline industry changing the perception of both customers and the airlines. These events lead to additional security restrictions and general apprehension towards flying in turn reducing the demand for airline travel. The industry suffered heavy financial losses leading to bankruptcy and reduction in workforce. The report analyzes the market structure of the airline industry. It also includes the effect of economic factors like substitutes, demand elasticity, and income elasticity. Statistics from the last ten years indicate that most of the major carriers have reduced the number of seats by millions in addition to reduced or terminating services to smaller airports. This loss of revenue also led to increased passenger fares and introduction of ancillary fees like baggage fees and premium seating fees. Other factors like mergers, acquisitions, demand changes, competition from low cost carriers, and fuel prices have played a significant role in changing the strategy and outlook of the big airline carriers . Smaller, low cost carriers have been able to penetrate the industry effectively where major airlines have been operating as a monopoly. Bigger carriers invest a lot of capital in airport gate rentals in order to maintain their presence in the market and this model keeps them from being able to offer lower fares. Smaller, low cost carriers follow a very agile model by renting these gates from bigger carriers instead of trying to monopolizing a single area. This enables them to operate at lower costs in turn giving a low cost option to customers. This analysis gives us a good insight to how airline firms have been impacted by the market conditions over the last thirteen years. This report highlights the changes in the airline industry since 2000 focusing specifically on how U.S Airways has adapted to these changes over the years. U.S Airways had filed for bankruptcy in 2002 and again in 2003 and resolved to reemerge as a competitive carrier. This report also discusses the plethora of innovative changes that U.S airways implemented in an effort to regain the market share. '' '' '' '' Important ''Important points for the reader ''II. P'''''ImBackground Analysis since 2000 – current situation A. ''The economic Environment '''1. 'GDP and Inflation' 2. 'Production' 3. 'Spending (CIGXM and Federal Reserve)' 4. 'Forces and Trends relevant for Industry and Firm' B. '' ''H. '' ''V. ''B. Industry ''W. 1. The Airline Industry The Airline Industry is fundamentally part of the Service Industry. Airlines perform a service for their customers, transporting passengers and theri belongings from one point to another at an agreed upon price. However, airlines require a lot more costs up front to create this service compared to other businesses. Their large fleets, facilitators, and maintenance hangars account for a very large cash flow. Today Airlines are dominated by a few large carriers, and many smaller carriers that focus on mostly domestic flights. When 9/11 occurred, all aircraft carriers were shut down for a short period of time. This shut down increased fuel prices, and most commercial air traffic fell in the next two years. This led to some major airlines’ bankruptcy, including United, US Airways, Delta and Northwest. Since 2006, these airlines have been working to re-start their growth and air travel is currently booming. Airline revenues can be split into the following four categories: - International, with annual revenue of $1 billion or more - National, with a revenue of $100 million to $1 billion - Regional flights with a revenue of $100 million - Cargo flights, which are used to transport goods. The largest proportion of revenue is fueled by passengers, both business and leisure. Today, airlines focus many of their strategies and decisions on the choices they think both business and travel passengers will make. The airline industry has changed the way people live and conduct business by shortening travel time, and altering perspectives on distance. Airlines make it possible for people to now travel easily and conduct business in places that were once considered remote. '''2. 'Size of the Industry relative to economy' The airline industry is a major part of the U.S. economy, as it directly and indirectly generates over $1 trillion annually in economic activity; this means that over 5 percent of the country’s GDP is generated by the airline industry. The airline industry also contributes $380 billion in the United States’ earnings. A good portion of the industry’s contribution to the GDP is generated directly through the sales of seats to domestic and international passengers and through providing jobs to millions of Americans, while a smaller portion is generated through indirect methods such as the sales of goods imported and exported by using the airlines. Additionally, the industry provides more than 11 million jobs to Americans, underscoring the important role it plays in the U.S. economy. Although some critics may argue that 5 percent of the country’s GDP is not enough to qualify the industry to be counted as a vital part of the economy, there are other factors which make the airline industry a crucial player in maintaining economic stability and growth. Without commercial aviation the United States would not have the economic power it holds today, as aviation and the airline industry made it possible for the U.S. to establish international commerce and become a major participant in the global economy. The airline industry also contributes to the domestic and local economies by connecting cities together across the vast expanse of American land. While the physical size of the airline industry or its financial contribution to the country’s GDP may not be the biggest, the industry’s decline or demise would definitely be felt and cause repercussions because of how vital of an infrastructure it is to the United States’ economy. 3. 'Market Structure – U.S Airways' The airlines industry is an oligopoly with monopoly pricing at major hubs. With few major airlines, they have a considerable amount of power to set prices for their amount of supply. “There are mainly three types of airlines-major, national, and regional. Major carriers are the largest carriers with domestic and international routes and the largest market share. National carriers focus on concentrated routes. Regional carriers are the most numerous but with the smallest market share and fly smaller aircrafts on thinly travelled routes primarily feeding passengers into the larger routes. After deregulation in 1978, there was a rash of mergers leading to fewer airlines and greater oligopoly. Since then low-cost airlines and national and regional airlines have expended and eating into the market share for the larger carriers. In turn the larger carriers have increased mergers further reducing the number of major airlines and increasing the magnitude of single-firm dominance. A few non-major airlines also operate independently as close affiliates of the major airlines. Non-major airlines have gained some market share in light of financial problems major carriers faced. Alliances and affiliations link carriers with each other. Operating agreements link regional airlines acting as feeder service to major airlines. Because of these cooperative agreements, truly independent number of suppliers is lower in the industry as compared to the number of airlines. Major airlines have also formed cooperative agreements in which they use each others scheduling, ticketing and marketing partnerships. Airlines have also formed global alliances with major foreign airlines that has evolved into international groupings. These affiliations require extensive cooperation among potential rival airlines. This suggests that effective decision making in the airline industry is greater than the firm’s individual share would indicate. There are several barriers that limit the entrance of new carriers. Major airports are accessible only to carriers holding government slots. These permits were originally allocated to the dominant airlines and the airlines have maintained or even increased their share of the permits. Second the dominant carriers exert control over the facilities usage at the airports through agreements with local airport authorities. Third, the major airlines have used the computer reservation and ticketing systems to their benefit by manipulating the onscreen presentation of flights and incentives to travel agents. Fourth, major carriers can use their lobbying power to create additional barriers to competition. Mutual interdependence enables the airlines to fly with tight pricings. " 4. 'Production (costs, economies of scale, constraints on inputs)' According to the Air Transportation Association, the top two costs airlines face are labor and fuel. Labor costs can be attributed to pilots, flight attendants, baggage handlers, dispatchers, customer service, and others. While large carriers spend a lot on fuel, smaller carriers get worse mileage because of the frequency of take-offs and landings during short flights. From the year 1999 – 2000, fuel prices had doubled and labor costs were increasing quickly. Air travel was popular, and airlines were sending more planes and scheduling more routes that exceeded the demand for flights. The airline industry was faced with growing technology that changed the way passengers were buying tickets, how passengers were being seated, and how gate agents were allocated. This new technology helped cut down on costs elsewhere, and made up some of the increase in fuel prices. Below is a chart that outlines the relationship between labor and fuel costs for the last decade. In 2008, fuel surpassed labor as the larget portion of airline costs. This is mainly due to the recession the United States faced. The chart below shows how fuel costs spiked during this recession, and has slowly been recovering since. With labor and fuel included, the list below outlines nine major categories of cost airlines face: - Flying Operations - Maintenance - Aircraft and Traffic Service - Promotion / Sales - Passenger Service - Transport Related Services - Administration - Depreciation / Amortization Once 9/11 hit, all airlines suffered major losses, some even resulting in bankruptcy. After five years of recovery, major airlines adjusted their production and by 2005, they were putting fewer planes in the air. The combined operating fleet of the six major airlines was 2,747 which was much lower than the 3,469 they had in the year 2000. With a smaller number of planes in the air, airlines were able to increase fare prices for everyone. However, by 2005 and into 2006, fuel prices began to surge again. Over the last twelve years, the consistent rise of fuel has caused some airlines to take drastic measures. Today, US Airways and American Airlines are considering a merger, and Delta has plans to buy a refinery to gain control over fuel. Other airline companies are looking into alternative fuel, including the nascent biofuel industry. The largest airline carriers average higher costs and lower productivity, resulting in diseconomies of scale. Smaller airlines are able to manage costs of labor by having a simpler fleet of planes. This keeps production and maintenance costs small, as well as the size of crew handling the planes. Larger airlines however have many more types of planes that need a larger crew that is specialized in many different aspects. Unions have capitalized on this labor, and have increased the cost of their crews.Fuel and labor dominates the airline industry, and these two costs directly affect the way airlines operate. 5. Demand ''' A characteristic of demand is the urgency of the trip and the flexibility of the flyer’s schedule. Leisure travelers are more elastic and sensitive to price. They look for substitutes and more options as the fare price increases. Business travelers have a low elasticity as they often have to travel on short notice. Airlines use price-discrimination to use the different elasticities to their advantage. Though in recent years, business travelers are becoming more inelastic and airlines are experimenting with lower fares. Studies have indicated that another variable that factors into the elasticity for airline ticket price is length of the trip. The use of cars, buses, and trains is a substitute service that can be utilized in place of shorter airline flights. Therefore, shorter distanced airline ticket prices tend to be much more elastic than those of long-distance trips. To counter, long-distance flights have far less substitutes, particularly international travel in which large bodies of land or water must be covered. Research industries have estimated the price elasticity for long-haul international business at -0.26% while long-haul international leisure trips have a calculated elasticity at -0.99%. Likewise, long-haul domestic business trip elasticity was calculated to be -1.15% while long-haul domestic leisure trips were -1.15%. This provides a direct correlation between the length covered for a flight, in addition to the particular type of trip, and the percent quantity demand. Thus, we can conclude that traditionally, international flights have been more inelastic than those of more elastic-based domestic flights. In the first two months of this year, domestic available seat miles, a measure of U.S. industry capacity, dropped 2.8% to 113.2 billion from 116.5 billion a year earlier, while U.S. airlines filled more seats -- 74.3%, up from 70.7%. With the cuts in capacity and strong demand, big airlines are enjoying their strongest pricing power in five years, and for the first time the ability to pass on a substantial share of lofty fuel costs to their customers. In some cases the total revenue has increased with increased passengers. In other cases the total revenue remains the same with lower price and increased quantity. Airfare is a normal good. As the number of passengers increases, there is a greater demand for seats. Future expectation is that prices are not going to decrease anytime soon. For distances of 300 miles or more, no close substitutes exist. When oil prices rise, airfare tickets also rise as they are complementary goods and have positive cross-price elasticity. Airline travel is still a luxury thus has a positive income elasticity. Marginal revenue increases at a decreasing rate. ''C. '' Firm ''D. '''' 1. 'Market Power, strategies, goal' US Airways, as one of the legacy carriers, has always had a considerable amount of market power in both the domestic and international economy. The company started its expansion by absorbing smaller carrier airlines throughout the late 1960s and early 1970s, and by 1973 the company was the ninth biggest airline in the entire world. The company continued to grow even after the Airline Deregulation Act of 1978, expanding its routes and networks to the Southeast United States. Currently, US Airways holds about 8.3% of the domestic airline market share, placing it in the top 5 airlines in terms of market shares. Things could change, however, if the proposed merger with American Airlines is approved; if the two airlines merge into one company, it would form the largest airline in the world. This would obviously change the dynamics of the market power and greatly increase the amount of market power that US Airways holds in the economy. There are concerns about the merger violating U.S. Antitrust laws, as opponents of the merger are afraid the merger will result in a monopoly power controlling the airline industry, but even without the merger US Airways does hold a considerable amount of market power. Having focused on the economic environment and Industry in the previous sections, we are moving on to discuss about U.S. Airways, their objectives, strategies, goals and future road map. U.S. Airways has been around since the 1930s and with partnerships and mergers with various airlines they have been able to establish a strong presence in both domestic and international markets. In the last ten years, U.S. Airways has overcome two bankruptcies. They have focused on improving certain aspects of their business to recapture a bigger share of the market. Some of their primary objectives have been described below: · Focus on Operation · Optimized Capacity · Developed New Revenue Sources · Invested in Customer Products & Services These objectives as basic as they may seem are very difficult to achieve given the current customer perception around the airline industry. Some of these were difficult decisions and required a lot of investments but U.S. Airways decided to move forward with these objectives and it paid them great dividends. U.S. Airways began to improve their operations by focusing on better baggage handling, on time performance and completion rate. They strived to reduce the number of cancelled flights and enforce published flight times. In 2008, U.S. airway was the number one on-time airline among the ‘Big-Six’ hub-and-spoke airlines according to the U.S. Department of Transportation’s monthly Air Travel Consumer report. They repeated this achievement in Q2 and Q3 of 2010 and paid out their employees a total of 24 million (overall YTD total) for delivering these results. These gestures along with their employee profit sharing program are getting them closer to better employee satisfaction. In October 2010, U.S. Airways started implementing a strategic plan to strengthen its core networks by reallocating their operations from their four major hubs (Charlotte, Philadelphia, Phoenix and Washington D.C). This enabled them to present a substantially higher percentage of their seat miles by end of 2010. They were almost at ninety nine percent as compared to ninety three percent in 2009. In addition, they started introducing new domestic and international destinations both directly and partnering with other major domestic and International carriers like British Airways, Spain air, and TACA airlines etc. This increased their market share slowly but steadily. They also partnered with Delta Airlines for additional presence in New York, Sao Paulo and Tokyo in exchange for allowing Delta access to Washington D.C. In 2008, they built a new state of the art operations control center in Pittsburg that controlled the flight dispatch for more than 1300 mainline flights. This improved they operation efficiency considerably. Like all other airlines, U.S. Airways began to explore other revenue opportunities like ancillary revenue which amounted to about $585 million additional revenue in 2012. U.S. Airways through the last ten years has invested heavily in improving customer service and experience. Current technological advances have changed the way the end consumer operates and it is imperative that the airline industry caters to these customers. Unless the airlines keep up with technological advancements, they would be left far behind in a tight race for the market share. U.S. Airways has devoted a lot of time and capital towards becoming the first and best in the latest technologies. In 2002, they introduced web check in and self check in kiosks making it possible for customers to book tickets, check-in luggage and obtain their boarding passes fairly quickly. They joined the star alliance network in 2004 which allowed U.S Airways customers access to star alliance lounges, check in and other ticket services. U.S. Airways was awarded the Freddie Award in the best promotion category for dividend miles popular ‘Everything Counts’ program which allows members to accrue miles through an assortment of partners. In 2009, they introduced their Power- Nap Sack pillow and blanket kits along with Wi-Fi and newest Trans-Atlantic lie-flat business class cabin (Envoy Suite). They launched FastPathSM – an expedited airport experience for the Boston – Philadelphia routes. This provided customers with quicker access to check in, baggage drop, departure gates, and baggage claim. In 2011, FAA validated the airline’s fully functional Safety Management System (SMS), making U.S. Airways one the first airlines to receive this endorsement. U.S. Airways has consistently been showing improvements in their profits over the last few years and the employees have been seeing increased profit sharing checks each year. Since 2005, U.S. Airways’ margins have been up 10 points and outdoing the average industry margins as well. 2. 'Production' September 11th, 2001 not only marked a pivotal point in American history, but also in the American market. This time can be looked at for which a turn in company production decreased. The market more so began operating on the diseconomies of scale suggesting that large operations would suffer higher costs and lower productivity. This trend grew more pronounced following the events of 9/11 as financial losses approximated $35 billion between 2001 and 2005. The American economy became stagnant to an eventual “recession” labeling. It should be noted that the following conditions were implemented under resulting decreases in consumer demand. The company utilizes the traditional factors of production with both fixed and variable inputs. The company directly felt the effects of soaring fuel prices which dramatically bolstered the prices of operation. U.S. Airways twice filed for bankruptcy following price spikes in jet fuel coupled with decreased demand. Additional production factors, including the cost of labor and employee pensions, further added to increasing costs. While the variable costs of labor and employee pensions remained relatively constant, the increased costs of fuel and oil substantially increased the total costs for the company. The total costs of production for U.S. Airways to continue operating within the parameters of the economies of scale were significantly greater than those of the smaller, lost-cost airlines. A 2004 study revealed that the cost per available seat mile for major airline carriers was 2.7 cents greater than those of the lower cost airlines. While 17% of the price difference was attributed to fuel and oil, approximately 28% of this difference was directly accredited to the costs of labor. Partially attributed to the large, diverse carrier fleets required greater expenses for maintenance and repair with specialized labor mechanics. The smaller airline carriers were better equipped to minimize costs through simplifying parts needed for maintenance with streamlined airline fleets and enhancing the flexibility of its crews. Additionally, operating as a major carrier utilized hub control to accommodate numerous flights within narrow time periods. Labor costs were bolstered by the price to maintain flight gates, ground facilities, and airport crews. The company’s merger with American West in 2005 added to the turmoil, while probably a great acquisition under to economies of scale, the increased size only further compounded the negative effects within diseconomies of scale. The combination of these factors meant that major carriers were operating at higher total costs. In the short-run, the company needed to lower the costs of production by decreasing the variable costs which could actually be controlled. In order to compensate, U.S Airways slashed fall flight schedules, jobs, and airline fleets to cut company expenses in hopes of operating at a more efficient level such as those demonstrated by the smaller, low-cost carriers. Major cutbacks in employment numbers, number of planes flown, hub abandonment, and capacity reduction (number of total seats per plane) were the resulting actions. U.S Airways primarily targeted short-run costs to counter immediate revenue loses. In 2005, large airline carriers, including U.S Airways, had successfully streamlined air fleets to lower production costs. There was a noted 21% decrease in the number of fleets in operation, down to 2,747 from a previous number of 3,469 at the end of 2000. By 2006, the company had rebounded in light of an improving economy and was able to place 347 airlines back into operation with approximately 21,894 employees. With an improving market, airline competition increased. The market price for tickets became a competitive strategy between carriers. The market began to further operate under the economies of scale. While operating as a major carrier, U.S Airways did not control as much of the market as the larger legacy carriers. Instead of market control, U.S Airways’ key to sustainability was to remain efficient with low production costs. While the economy improved, so did the demand for airline travel. U.S Airways was still in the diseconomies of scale with streamlined fleets. The second quarter of 2012 illustrated how the increased number of occupied seats on flights in combination with lower costs of production proved beneficial as U.S Airways earned $287 million. Despite the effects of fluctuating fuel prices, airtraffic improved and the company competed for the rise in consumers. Flight loads increased suggesting the need for larger planes and more staff. These increases would add to costs of production. Most recently, U.S Airways has negotiated plans for merger with American Airlines. Of the many benefits to geographical expansion, growth, and customer service improvement. The merger grants the company massive cost synergies. To become more competitive with United and Delta in the recovered market, the company needed to increase its production potential. However, governmental officials have discussed blocking this proposed merger as U.S Airways would be successful on its own and the merger of the two carriers would do nothing to decrease airline fares. In response to the precautionary cuts, U.S Airways was braced in crash position when their market tanked last fall. With the market gradually recovering, U.S Airways continued to increase its air traffic throughout 2013. ' ' ' ' 3. 'Demand' Following the market collapse in 2001, demand within the airline industry reached a low. Studies show that previous growths in domestic passenger for airlines dramatically slowed during this time. The industry directly felt the effects of the economic recession. Decreased airline traffic coupled with increased fuel prices forced the company into bankruptcy from 2002 to 2005. U.S Airways and the other airline carriers operate along the traditional functionalities of demand. With an inability to control all the influential factors, such as income and number of consumers in the market, U.S Airways primarily focused on manipulating flight demand through price. Firms in the industry can only regulate the price of air fares in comparison to successfully compete with substitutes. Bus, train, boat and car travel are all competitive substitutes for airline travel in addition to other airline carriers. Adapting to the industry’s elasticites regarding short- and long-distance travel, U.S Airways has been able to manipulate demand through price discrimination. With the economy in a slump following 9/11, the difference in average fair charged to business travelers and leisure passengers decreased significantly. The economic downfall in combination with soaring fuel prices ran airlines companies bankrupt, including U.S Airways twice. Many of the smaller airlines were not mature enough or simply could not stand the tough years. The early 2000’s yielded at least 10 to 12 airline competitors. Several competitors were not able to thrive during the market collapse and competitive changes which eventually caused a number of carriers to go out of business. With less competition, U.S Airways experienced an increase in demand. For airlines, ticket price is influenced more by route competition that miles traveled or cost of flight and that ticket price in this sector drives revenue and earnings. As a larger carrier, U.S Airways was able to better competitively participate in airport gate and air route manipulation to route competitors. The company was able to control gates such as Philadelphia International Airport, at one point operating 48% of the share, consequently forcing small competitors to fly out of smaller airports. Control of these larger hubs also gave access to international flight routes. With increased global trade and tourism, U.S Airways was capable of successfully competing within the sector of long-distance business flights as well as long-distance leisure. Corporations have become capable of placing employees at the far ends of the globe increasing international travel. With the speed or air travel proving more beneficial than sailing across large bodies of water or riding trains across large land masses, airlines predominately controlled long-distance travel sectors. The ability to control gates to limit competition at these international airports allowed for price discrimination to be utilized regarding long-distance air travel. Air route manipulation more so focuses on controlling the highly demanded routes of consumers. With U.S Airways controlling the Philadelphia hub, heavy traffic routes such as the Philadelphia-Boston route were controlled by the company. To again limit competitors attempting to use routes such as these, the company would slash prices to increase company demand until the competitor was forced to bail out. At which time the company could raise pricing again with no fear of competition. As several competitors went out of business during the recession, U.S Airways now primarily competes with larger carriers such as United and Delta, which are the number one and number three largest carriers. Given the proportion of market control the larger carriers’ control, they are better suited to compete through competitive and even predatory pricing. The larger carriers have been able to offer lower pricing on airline fares to attract more customers. These larger carriers also are able to gain greater hub control and operate more gates. To remain competitive in the long-run, U.S Airways needs to increase its production potential. In possibly merging with American Airlines, U.S Airways will be better suited to eliminate competition which would allow for better price control in the short-run. This allows for immediate gains until better long-run plans can be implemented. The company should continue to expand its control in the increasing market. III. 'Forecast/Projections/Recommendations' A. 'Economic Environment' B. 'Industry' C. 'Firm' a. Reaction to macro changes and effect on strategy b. Reduce costs of production c. Develop a new product or expand into another area of the market